1031 Exchanges in Connecticut: What Investors Need to Get Right at the Closings
A 1031 exchange lets a Connecticut investor defer capital gains tax by rolling one investment property into the next, but two federal deadlines and strict rules about the money decide whether it works.
What is a 1031 exchange?
A 1031 exchange is a properly structured exchange under Internal Revenue Code Section 1031 that can defer recognition of gain, and therefore defer tax on that gain, when real property held for business or investment is exchanged for like-kind replacement real property also held for business or investment. The gain is deferred, not forgiven: the tax bill moves into the future rather than disappearing. For exchanges completed after December 31, 2017, Section 1031 generally applies only to real property held for productive use in a trade or business or for investment, and not to property held primarily for sale. Property used primarily for personal use, including a primary residence, second home, or vacation home while so used, generally does not qualify for like-kind exchange treatment. Converted, mixed-use, or rental-vacation properties require tax-advisor review. Receiving cash, debt relief, or other non-like-kind property can create taxable "boot," so a partial exchange may still qualify while only part of the gain is deferred.
Mancuso Carey handles Connecticut real estate closings, including the Connecticut closings in a 1031 exchange. This article covers what an investor needs to get right on the closing side of an exchange in Connecticut, not whether an exchange makes sense for a given deal. That second question belongs to a tax advisor.
What property qualifies for a 1031 exchange in Connecticut?
Most real estate held for investment or business use is like-kind to other investment or business real estate. The IRS's own example: a rental house is like-kind to vacant land. A rental house, a multifamily building, raw land, or commercial real estate can each qualify when it is held for business or investment use.
Real property inside the United States and real property outside the United States are never like-kind to each other, so a Connecticut rental cannot be exchanged into a foreign property. The replacement property does not have to be in Connecticut, because the like-kind rules are federal.
What are the two 1031 deadlines?
Two deadlines govern a 1031 exchange, and both run from the day the sale of the relinquished property closes. The replacement property has to be identified within 45 days of that closing. The replacement property then has to be received within 180 days of the closing, or by the due date (with extensions) of the tax return for that year, whichever comes first. Neither deadline can be extended for hardship; the IRS makes an exception only for presidentially declared disasters.
The 45-day identification has requirements of its own. It has to be in writing, signed, and delivered to someone involved in the exchange, such as the qualified intermediary or the seller of the replacement property. Telling your own attorney, real estate agent, or accountant about your plans does not satisfy this requirement. An investor who transfers property in a like-kind exchange during the tax year also has to file IRS Form 8824 with that year's return.
Investors also need to avoid over-identifying replacement property. The regulations generally allow identification of up to three replacement properties regardless of value, or any number of replacement properties if their aggregate fair market value does not exceed 200% of the relinquished property's value, with a narrow 95% rule exception.
Why can't the sale proceeds come to you?
In a typical delayed exchange using the qualified-intermediary safe harbor, the sale proceeds should be directed to the qualified intermediary under the exchange documents, not to the investor's bank account. If the investor actually or constructively receives the cash or other proceeds before the exchange is complete, the exchange can fail or the investor can recognize taxable gain. The qualified intermediary is the independent party used in this common safe-harbor structure to hold or control the exchange proceeds between closings.
If the investor actually or constructively receives the cash or other proceeds before the exchange is complete, the exchange can fail or the investor can recognize taxable gain.
An investor cannot act as their own qualified intermediary. Nor can a disqualified person serve as the qualified intermediary. That generally includes someone who has acted as the investor's employee, attorney, accountant, investment banker or broker, or real estate agent or broker during the two-year period ending on the transfer of the first relinquished property, except for prior 1031-exchange services and certain routine financial, title-insurance, escrow, or trust services.
How does Connecticut regulate qualified intermediaries?
Connecticut regulates exchange facilitators, a category that includes qualified intermediaries, under General Statutes sections 36a-830 to 36a-837, which took effect October 1, 2013. The law is not limited to Connecticut relinquished property. Connecticut regulates several Connecticut-connected exchange-facilitator roles, including a facilitator with a Connecticut office that solicits exchange business, a qualified intermediary handling a client's relinquished property located in Connecticut, an exchange accommodation titleholder taking title to property in Connecticut, and certain qualified trustees or escrow holders covered by the statute.
At all times, a covered exchange facilitator must maintain either a fidelity bond of at least $1 million, a separately identified account for exchange funds requiring written authorization from both the client and facilitator for withdrawals, or a qualified escrow or qualified trust with dual authorization. The facilitator must also maintain at least $250,000 of errors-and-omissions insurance or an equivalent alternative in cash, securities, or irrevocable letters of credit. In most cases, a facilitator must also notify its Connecticut clients if control of its business changes.
The IRS warns that some intermediaries have gone bankrupt or failed to meet their obligations, causing taxpayers to miss exchange deadlines. Pick a qualified intermediary with the same care you would give to picking a lender.
What does the closing attorney do in a 1031 exchange?
When engaged for both Connecticut closings, Mancuso Carey can conduct the sale and purchase closings and coordinate with the investor's qualified intermediary so the sale, the funds, and the purchase line up. The firm keeps the 45-day and 180-day clocks in view as the closings are scheduled. The exchange has to be set up before the sale closes: the contracts, assignments, and intermediary agreement need to be in place ahead of that closing, not after it.
The closing attorney is one of three seats at the table. The qualified intermediary is an independent party who holds the proceeds, a role the closing attorney coordinates with rather than fills. Whether an exchange makes sense for a given investor is a question for that investor's tax advisor. The sale side is still a Connecticut sale with its usual closing costs; what it costs to sell a house in Connecticut walks through them. For more on how the firm works with rental and commercial owners, see working with Connecticut investors.
Frequently asked questions
Is Mancuso Carey the qualified intermediary?
No. The qualified intermediary is a separate, independent role that holds the sale proceeds between the two closings. Mancuso Carey handles the closings and coordinates with the investor's intermediary so the sale, the funds, and the purchase line up.
Does the replacement property have to be in Connecticut?
No. The like-kind rules for a 1031 exchange are federal, and most investment real estate is like-kind to other investment real estate. The replacement property has to be in the United States, because property inside and outside the country is never like-kind, but it does not have to be in Connecticut.
Can I do a 1031 exchange on my home?
Generally, no. Property used primarily for personal use, including a primary residence, second home, or vacation home while so used, does not qualify for like-kind exchange treatment. Converted, mixed-use, and rental-vacation properties are a question for your tax advisor.
When should I call a closing attorney about an exchange?
The best time is before the sale contract is signed. An exchange has to be set up before the sale closes, so the contracts, assignments, and intermediary agreement need to be in place ahead of that closing. An early call gives the closing attorney time to coordinate with the qualified intermediary and keep the 45-day and 180-day clocks in view from the start.
Many exchange problems are mechanical: missed deadlines, defective identification, improper funds flow, or paperwork that is not in place before closing. Mancuso Carey brings 10,000+ Connecticut closings and 15+ years serving Connecticut to the closing side of an exchange, and we respond within one business day. If a Connecticut 1031 exchange is coming up, book a free consultation and we'll get the closing side ready for it.
This is general information, not legal or tax advice. Every situation is different, so reach out to discuss yours.